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What is Link Rot? Simply put, link rot is the inevitable increasing occurrence of broken links. There are two types; internal broken links and external broken links. Internal broken links are those within a website which are pointing to items on that website which are no longer there. These can be web pages, graphics, etc. External broken links are those which point to items on others' websites. These are the most common contributors to link rot as websites are often revamped or completely redesigned or the site simply no longer exists.
Why should one monitor link rot and deal with it quickly?
Two reasons; website user experience and Search Engine Placement. Obviously, getting "404 file not found" and/or being redirected to another web site's home page when they expect a particular product or informative article, is going to be a negative user experience for users. When someone clicks on a link that says "article about widget A", they expect to see an article about widget A. That's the deal. That's how the "interwebs" work. When the user does not have this experience, they go elsewhere.
Follow up:
Link rot harms a site's search engine placement. You can count on the fact that Google's uber secret, ever changing, ranking algorithm factors in the amount of link rot on a website. They know a site with little to no link rot is well maintained and one with a great deal of link rot is likely on its way to being no more. So be well aware, part of keeping one's web site Search Engine Optimized is the ongoing link rot battle.
To get a quick glimpse of your internal broken links or broken links to items within your site from others you can check your web log statistics. For awstats, scroll to the bottom of your stats page until you see:

Notice the "404" beside "document not found" is a link. Click this and it will give you a list of items which where requested but not found on your site. Now before you freak out because there are a lot of items here, realize that most are from bots sniffing for vulnerabilities. If there is no source for the request in the "Referers" column then it is likely sniffing and can be ignored. HOWEVER if there is a referer then you should track this down and address it.
There are several tools available to site owners to help them monitor and deal with not only internal but external link rot. The first is the W3C's Link Checker FREE online service. There you'll see the following:
The W3C link checker is limited to 150 pages so you may have to break up your checks to different sections of your site if you have a great deal of external links. The W3c link checker can be slow as well since it waits one second between link checks, but it is FREE.
There are numerous programs you can purchase if you need to check in the upwards of 2000+ links on a site quickly and frequently. Web Link Validator is one such tool that will let you check up to 500 links in it's trial mode which you can download from Cnet Downloads.
Now, let the Battle Against Link Rot Begin! And good hunting.